Question

Terminal cash flow-Replacement decision Russell Industries is considering replacing a fully depreciated machine that has a remaining useful life of 10 years with a newer, more sophisticated machine. The new machine will cost $195,000 and will require $30,500 in installation costs. It will be depreciated under MACRS using a 5-year recovery period (see the table for the applicable depreciation percentages). A $29,000 increase in net working capital will be required to support the new machine. The firm's managers plan to evaluate the potential replacement over a 4-year period. They estimate that the old machine could be sold at the end of 4 years to net $14,300 before taxes, the new machine at the end of 4 years will be worth $80,000 before taxes. Calculate the terminal cas The terminal cash flow for the replacement decision is shown below: (Round to the i Data Table SL Proceeds from sale of new machine Tax on sale of new machine Total after-tax proceeds-new asset Proceeds from sale of old machine Tax on sale of old machine Total after-tax proceeds-old asset Change in net working capital (Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes Percentage by recovery year* Recovery year 3 years 5 years 7 years 10 years 33% 20% 14% 10% 45% 32% 25% 18% 15% 19% 18% 14% 7% 12% 12% 12% 12% 9% 5% Terminal cash flow 9% SOC VOUAWN 4% 6% 6% 4% Totals 100% 100% 100% 100% *These percentages have been rounded to the nearest whole percent to simplify calculations while retaining realism. To calculate the actual depreciation for tax purposes, be sure to apply the actual unrounded percentages or directly apply double-declining balance (200%) depreciation using the half-year convention

Answer 1

When the new machine is sold at the end of 4 years, the tax basis = Assets'book value not depreciated till the end of year 4 = Cost x (12% + 5%) = (195,000 + 30,500) x 17% =  38,335

Gain on sale = Sale value - tax basis = 80,000 -  38,335 =  41,665

Hence, tax = Gain x tax rate =  41,665 x 40% = 16,666

Please see the table below now, it contains all your answers highlighted in yellow colored cell.

			Linkage
Proceeds from sale of new machine	80,000		A
Tax on sale of new machine	16,666		B
Total after tax proceeds - new assets		63,334	C = A - B
Proceeds from sale of old machine	14,300		D
Tax on sale of old machine	5,720		E = 40% x D
Total after tax proceeds - old assets		8,580	F = D - E
Change in net working capital		29,000	G
Terminal cash flow		83,754	C - F + G